Hedge funds remain cautious on the outlook for oil prices despite confident statements from Saudi Arabia that global oil inventories will decline substantially in the next few months.
Asset managers cut their combined net long position in the three main futures and options contracts linked to Brent and West Texas Intermediate (WTI) by 39 million barrels in the week ending June 6.
The net position had been increased by a total of 114 million barrels over the previous three weeks, analysis of data published by regulators and exchanges showed.
The earlier increase, however, was driven mostly by covering of short positions rather than the creation of new longs and the short-covering now seems to have run its course.
Hedge funds added 24 million barrels of new short positions in the most recent week, all in Brent, where shorts rose by 33 million barrels.
The ratio of long to short positions fell to only 3.1 to 1, well short of the recent peak of 5.8 on April 18, let alone the record 10.3 set in February.
From a positioning perspective, the balance of risks is now on the upside, with few long positions left to be liquidated and a relatively large number of short positions that need to be covered.
Brent prices are trading close to their lowest since the Organization of the Petroleum Exporting Countries (OPEC) announced it was cutting output on Nov. 30, which also suggests some potential for a bounce in the short term.
Saudi Arabia has offered some support by reiterating its determination to bring global oil stocks down to the five-year average, though policymakers have so far resisted pressure to cut output again.
But the continued rise in the number of rigs drilling for oil in the US has made it hard for fund managers to become bullish again.
The number of rigs targeting oil-bearing formations has more than doubled over the past 12 months, even though WTI prices are down by about 6 percent. The rig count has continued to climb even after WTI prices peaked in February and started to decline. Since production lags the rig count by six months, the recent increase in drilling will ensure that US output continues rising for the remainder of 2017 and into 2018.
The US Energy Information Administration (EIA) now forecasts output will increase by 460,000 barrels per day (bpd) in 2017, up from the 110,000 bpd rise forecast in January.
The agency expects production to rise by a further 680,000 bpd in 2018, against the 300,000 bpd forecast in January.
With so much extra production projected to come from the US, with output also increasing from Brazil, Norway, Libya and Nigeria, sentiment among hedge fund managers remains tepid. Fund managers have established large net long positions in crude twice this year, only for prices to drop sharply, leaving them with heavy losses. Many want firmer evidence that the market really is rebalancing before taking on risk again and going long for a third time.
n John Kemp is a Reuters market analyst. The views expressed are his own.

Source: Arab News